Updated April 29, 2017 12:05 a.m. ET
Consider investment-grade corporate bonds. They aren’t as important to the global economy as Treasury bonds, nor as exciting as junk-rated debt, so they’re easy to overlook. But they probably shouldn’t be.
Sitting in the middle of the risk spectrum, investment-grade bonds could be the perfect compromise for an unsettled time, when seemingly half the investing world expects a tax-cut-led economic revival, and the other half is increasingly pessimistic.
UNLIKE TREASURIES OR JUNK BONDS, investment-grade bonds are positioned to perform reasonably well under most scenarios.
If developed economies remain stuck in a new normal of low growth, inflation, and interest rates, junk bonds could be the biggest beneficiaries, as investors grab the highest-yielding debt they can find. But investment-grade bonds would still be close behind, since they yield more than government bonds.
If, on the other hand, the U.S. somehow breaks free, investment-grade bonds could prove to be top performers. Under this scenario, Congress would pass a large-scale overhaul of the tax code, bolstering economic optimism, and driving Treasury yields higher. Junk would probably benefit but perhaps not as much as investment-grade bonds. That’s because many junk-rated companies don’t earn enough to pay taxes, while some are vulnerable if Congress helps fund a lower corporate tax rate by eliminating the deduction for interest expenses.
Finally, if one catalyst or another manages to trigger recession fears, Treasury yields would probably decline as their prices go up; junk-bond yields would also rise. But investment-grade bonds wouldn’t necessarily change that much, reflecting the relative strength of their issuers’ balance sheets.
As it stands, investors are having a hard time quitting junk bonds. Over the past 12 months, junk has returned 13.9%, according to Bloomberg Barclays Indices data, versus 3.5% for investment-grade bonds and minus 0.2% for Treasuries. Year to date, those returns are 3.75%, 2.18%, and 1.32% respectively.
Clearly, the status quo has been good for junk bonds, and it could easily continue. Despite some alarming geopolitical headlines, the global economy seems to be in decent shape. Defaults among high-yield companies have been trending down. And yet investors are still waiting for the long-awaited handoff from monetary to fiscal policy, with interest rates low around the world and two of the three most important central banks still pursuing aggressive bond-buying programs.
“We are still in an environment where we have the Fed put backing us, basically,” says Karissa McDonough, a fixed-income strategist at People’s United Wealth Management. “As long as that backstop exists, I still think that more volatile asset…